Mexican energy reform to light up investors

December 2014 | FEATURE | SECTOR ANALYSIS

Financier Worldwide Magazine

December 2014 Issue

In the shadow of its more illustrious neighbours, Mexico is often overlooked by investors. Landmark developments in neighbouring states in both North and South America tend to garner the majority of press and investor attention. Latin American powerhouse Brazil, for example, has attracted sizeable amounts of infrastructure investment in the build up to both the 2014 FIFA World Cup and the 2016 Olympic Games. As an emerging market, Brazil has been a focus for many international investors, but more investment is required if the country is to fulfil its economic potential.

A consequence of increased investment in Brazil, as well as a resurgence of foreign direct investment into the US, Mexico has been largely overlooked as a potential investment destination despite its relative strength in the region.

However, the Mexican authorities have recently announced a significant program of reform which could potentially open the door for investors to capitalise on the country’s shifting economic landscape. Following a regulatory overhaul, the Mexican energy sector is set to offer investors a range of opportunities for the first time in decades.

The energy reforms, which consist of 21 new laws, were signed into law in August by President Enrique Peña Nieto. The new regulations effectively ended the 76-year monopoly of state-owned oil company Petróleos Mexicanos, or Pemex, in one fell swoop. Although 83 percent of the country’s proven and probable oil reserves have been promised to Pemex, the company has only been guaranteed 21 percent of Mexico’s possible reserves. The remaining 79 percent will be made available to private, likely foreign firms. A number of major oil companies including BP, Chevron, Royal Dutch Shell and Lukoil are all believed to be interested in the Mexican market and are expected to bid for the reserves.

The reforms have also brought an end to the decades-long dominance of the local electricity sector held by government utility Comisión Federal de Electricidad. The legislation is robust and will help to transform Mexico into an attractive and competitive destination for investment. Indeed Mr Nieto’s reform program is nothing short of a Mexican energy revolution.

Growth and investment

There is little doubt that economic growth in Mexico has been lacklustre in recent years. The country has generally failed to live up to the expectations of its citizens, politicians and investors alike. But the Nieto administration is keen to reverse that trend. As a result of the administration’s reform program, Mexico now has the lowest tax take in the OECD as a percentage of GDP. The government has also moved to revitalise and revolutionise the country’s telecoms and broadcasting industries. Some analysts have suggested that, as a result of these and other sweeping reforms which will impact upon the country’s education and banking systems, the Mexican economy could become the eighth largest in the world by 2050.

Mexican officials expect much of that economic growth to be built on the liberalisation of the energy sector. The reforms have been designed to draw new investment to the oil and gas sector by private and foreign firms seeking to tap the nation’s vast energy resources. Mexico has an abundance of conventional oilfields in shallow waters and mature onshore fields. It is in these onshore fields where the deployment of technologies new to Mexico, such as horizontal drilling, will significantly boost production, profitability and, crucially, investment. The deployment of this technology is likely to be carried out by new players in the Mexican energy sector. Already, a new exploration and production company, Sierra Oil & Gas, Mexico’s first independent exploration and production company, has secured equity commitments of $525m from energy-focused private equity firms Riverstone Holdings LLC and EnCap Investments, each of which committed US$225m in funding. Mexico’s largest infrastructure private equity firm – Infraestructura Institucional – has also committed $75m to the firm. Although the funds raised by Sierra are substantial, they are a mere drop in the ocean; Mr Nieto has indicated that the country hopes to attract around $50bn in energy investment annually over the next three years.

For investors, Mexico offers a great deal of low hanging fruit. Oil production in the country has suffered greatly from underfunding in recent years. Accordingly, if investors are to maximise the available resources in the country, significant investment will be required in the years ahead, although that funding will likely offer significant rewards.

Investment is also needed in Mexico’s infrastructure network. The country’s electricity infrastructure must be upgraded if Mexico is to properly capitalise on its resources. Notable investment will be required to accelerate the development of the country’s gas distribution infrastructure. It is also essential that the energy industry be better served by adequate transport networks if the desired growth is to be realised. If the government can institute reforms in infrastructure development and attract suitable levels of inward investment, it will be able to provide the energy sector with the networks that it desperately requires.

For those looking to Mexico for investment opportunities, there are likely to be many opportunities going forward. Mr Nieto’s reforms may be a genuine game changer.